Position Sizing and Leverage Trading

How To Position Size with Leverage?

So, the other day I received a question from new Mango Seedling in regard to Position Sizing when using Leverage:

"Hey Shawn,

“I’ve decided to start with a very small portfolio of a $1000 to get comfortable with longs and shorts

 if i did a 3x leverage does that mean I will input $3000 instead under the portfolio amount? "

It seems like some of you are still confused on how to position size your trades when putting on a leverage trade.

I've received similar questions like this in the past. So I thought I'd address this in a post.

Leverage vs Position Sizing

 Your leverage should NOT impact how you position size...ever!

Your position size is to be determined first, and your leverage only after the fact.  

Mango Analogy: Position Sizing & Leverage

Think about a simplified mortgage example:

 Let's say you wanted to buy a brand new 3-bedroom house.

After doing a lot of financial planning and thinking, you decide that you can afford a maximum of $500,000.

We can use this scenario to draw parallels to your trading:

1. "Financial planning & Thinking" =  Risk Management Strategy

2. "Afford maximum of $500,000" =  Position sizing.

Now you tackle the big question of the down-payment. 

Again, let's keep it simple and assume you only have to worry about liquidity and monthly payments.

After more thinking, you decide the following:

1. You have $100,000 of spare liquidity

2. You want to put 20% down-payment

Again, we can draw parallels to our trading here:

1. "20% down" = 5x leverage

2. "$100,000 liquidity" = The minimum you need to have in the exchange.

(In case you're confused here, let's break down the math:

You are buying $500,00 home. But you are putting down only $100,00 of your money, and borrowing $400,00 from the bank.

When you put down only $100,000 to buy a $500,000 home, you have essentially 5x'd your buying power.

You have taken a leverage trade on your house. )

So now you have determined your position sizing and your leverage. You go over to the bank, and talk to one of the useless mortgage brokers who pretend to know what they are talking about.

The broker says:

"Hey, you can afford a $1,000,000 home if you put a 10% down-payment instead of a 20% downpayment"

Hmm... let's think about this....What happened here? 

By decreasing your down payment, the broker has:

1. Increased your position size

2. Increased your leverage.

And most importantly:

3. Taken control of your Risk Management.

Red. Frigging. Flag.

Take Control Of Your Own Risk

Your risk management should be dictated by YOU (and the MRM Tool Sheet if you're in the Seed Program) before you even enter the exchange.

The position size remains constant once your risk criteria has been determined.

Remember from the program modules:

Do NOT let the exchange dictate your risk management. 

Again, remember that The Mango Way is:  RISK FIRST 

And your position size is a huge component of your risk. 

Once you've determined your risk, your position size is determined as well.

You should NOT change your position size... no matter what leverage you decide to use after that.

In fact, it's the exchange and leverage that should mould to your risk, not the other way around.

 Every exchange is going to have subtle differences in how you can EXPRESS your risk on the exchange.

The exchange is just a tool for your to express your risk.

Risk First, Leverage Second

Now let’s address this bit:

“I’ve decided to use $1000 for my portfolio….. my question is, if i did a 3x leverage does that mean i will input $3000? “

This is another example of letting leverage dictate your risk management (as opposed to the other way around).

Remember:  Your trade does not dictate your portfolio size, your portfolio size dictates your trade size.

Same rules apply here. If you're in the Seed Program and you're using the MRM Sheet, then your portfolio size remains fixed for the duration of the trade. (In this example, the your portfolio size should be set to $1000.)

Furthermore, it worth emphasizing that leverage is not used for position sizing decisions EVER

It's only used to increase efficiency and reduce counter-party risk.

Final Thoughts

New traders, disastrously, allow the temptation of high leverage dictate their risk management. 

Never do this. It's not the Mango Way!

Don't start with:
 "I want to 3x leverage so what should my position size be?"
 
Instead, start with : 
"What should my position size be? Oh, the MRM Sheet is saying $1000?" 
Okay, that means I need to put around $350 minimum in the exchange to so I can use 3x leverage to get to $1000 position size

Why $350?
Because 350 x 3 = $1050, this will be an approximate minimum of what you'd need to satisfy your MRM sheet.

But of course you can put more margin in your exchange account - for example $500.

However, if you set your isolated margin to 3x and position size to "$1000", it will isolate 330ish to give you the same position. And you'll have around $200 margin left over.

But now I'm ranting, and we're digressing to a new topic.

Hmm...Do you guys want me to discuss more on the differences between Isolated Margin vs Cross margin?

If so, let me know in the comment section and I'll get on it 🙂

KEY TAKEAWAYS:

• Do NOT let the exchange dictate your risk management. Your risk management is dictated YOU (and the MRM Sheet)
   
• The exchange and leverage should mould to your risk, not the other way around
  
  
• Your trade does not dictate your portfolio size, your portfolio size dictates your trade size
  
  
• Leverage is not used for position sizing decisions EVER It's only used to increase efficiency and reduce counter party risk